SRJC H2 ECONS 9757 Q4 MS

Explain the domestic and international factors that could cause deflation. [10] Introduction: Definition: Deflation is a sustained decrease in the general price level of an economy, or negative inflation rate. Direction of essay: This essay aims to explain how deflation occur due to a persistent fall in AD and/or persistent increase in AS that arises due to domestic factors and/or international events that is beyond a country’s control. P1: Deflation could be due a decrease in th e components of AD that results from domestic factors. E/E: A decrease in AD can be caused by a decrease in any of the components of AD – consumption expenditure (C), investment expenditure (I), government expenditure (G) and/or net exports (X-M) that arises due to domestic situation in the country. For example, when an economy experiences a recession, consumers would probably reduce their consumption expenditure (C) as the risk of losing their jobs increases. There will also be a fall in investment as recession usually result in lower business confidence as investors are uncertain about their future returns on their investment. As both investor and consumers demand lesser quantity of products a t each given price level during recession, there will be a leftward shift of AD from AD0 to AD1, resulting in a surplus at the original general price level. Due to the surplus, there will be a downward pressure on the general price level from P0 to P1. L1: However, if consumers expect a further fall in general price level in the future, they will start to hoard money, delaying consumption in anticipation of lower price in the next period. Business would see it as a fall in demand and will postpone investment. This will further decrease AD, which will bring about a further fall in general price level, hence resulting in a deflationary spiral, whereby the economy cannot recover, leading to ev en lower prices in a vicious cycle. P2: Deflation could be due a decrease in the components of AS that arises from domestic factors. E/E: An increase in AS can be caused by a fall in cost of production due to increase in labour productivity within the country. As Singapore is shifting towards a more technology -enabled Y0 0 AD1 AD2 Real National Income AS General Price Level P0 P1 Y1 Fig 1.

operation due to subsidy given to firms to engage in R&D. With greater use of capital goods, it means an increase in efficiency as it will help to increase labour productivity as more output could be produced within the same man/hr. Moreover, during the period 2004 to 2014, Singapore relaxed her immigration policy to attract foreign workers and immigrants. The increase in the supply of foreign workers in Singapore have resulted in an increase in labour productivity and productive capacity, causing a rightward shift of LRAS. L2: Deflation will only occur if the both domestic policies such as R&D and relaxation of immigration policies are long-term and effective. This will brings about persistent increase in LRAS (fig2) → rightward shift of LRAS curve → fall in cost of production→ downward pressure on price from P0-P1. Deflation could be due a decrease in the components of AD and increase in AS that results from international factors. P3: One of the international factors that cause a fall in general price level is due to recession faced by trading partners resulting in a decrease in AD. E/E: When Singapore’s trading partners such a USA is facing recession arising from subprime crisis, there will be a fall in US purchasing power resulting in a fall in demand for Singapore exports. This will cause a fall in Singapore net exports revenue especially when USA is Singapore major trading partner . The fall in AD would be expected to be large, shifting AD curve to shift left as seen in Fig 1 . At the original general price level, there was a surplus causing a downward pressure on the general price level from P0 to P1. L3: Deflation would occur when the fall in general price level is persistent. This would most likely to occur when USA is entrenched in a recession that would take a long time for her to recover. P4: One of the international factors that cause a fall in general price level is due to recession faced by trading partners resulting in a decrease in AS. Y3 0 AD1 Real National Income LRAS2 LRAS1 General Price Level P0 P1 Fig 2.

E/E: An increase in AS can be due to a fall in cost of production that arises from international events that is beyond the country’s control . For example, Singapore is a small and open economy that are heavily dependent on the import of key factor inputs. For example, American has been increasing global supply of oil due to its shale production boom. Due to this increasing global supply of oil, there has been an increasing fall in the global price of oil. Given that oil is a major factor of production → the falling price of oil will cause a fall in COP → increase AS→ a downward pressure on GPL. Moreover, given that oil is a major component in the computation of CPI, a falling price of oil will also indicates a falling CPI, hence illustrating a persistent fall in GPL. Conclusion: Deflation spiral could arise with both domestic and international factors occurring together. In an interconnected economy together, it is often difficult to distinguish which is the main trigger that result in deflation. Even when deflation starts with either a fall in AD or an increase in AS, it is often challenging to separate the two, the moment deflation spiral downwards. Marking scheme Level Descriptors 3 Thorough explanation of at least one domestic and one international factors causing deflation. Students have to explain the factors that cause a fall in AD and an increase in AS. To achieve 9m and above, students must be able to link to persistent fall in GPL. Usage of relevant examples. 2 Adequate explanation of how domestic and/or international factors cause demand -pull and cost-push inflation in Singapore Explanation of one type of inflation only [Max 5m for both domestic and international factors] Explanation of only 1 source of factors, either domestic or international factors. [max 5m] 1 Smattering of ideas. Listing rather than explanation of how deflation occurs. Y2 AD AS1 AS2 Y1 Real National Income General Price Level P1 P2 0 Fig 3

Substantial conceptual errors. Generally weak answer. Limited application of economic analysis. Discuss the alternative policies that a government could adopt to address deflation. [15] Introduction: If deflation is caused by a persistent increase in AS, there will be an increase in material standard of living as there is an increase in real income together with falling prices. It brings about higher purchasing power, hence greater consumption of goods and services. However, if the cause of deflation is due to a persistent fall in AD, it will bring about undesirable consequences such as lower material standard of living as consumers would delay consumption in anticipation of lower price in the next period. This results in lower consumption of goods and services and thus, lower material standard of living. Hence, Government would have to inter vene by implementing e xpansionary demand management policies to address the cause of persistent decrease in AD rather than the increase in AS. Body: P1: A government could pursue expansionary fiscal policy to address deflation. E/E: When deflation is caused by persistent decrease in AD, the government could increase the level of government expenditure and/or reducing corporate and personal income tax. The increase in government expenditure, for example on infrastructure such as roads and ports would increase